Focus on weak GDP growth, high dollar

Mark Mulligan

A welter of economic data this week will confirm soft second-quarter gross domestic product and point to whether or not the rebalancing of the Australian economy has gathered momentum since the end of June.

Private sector consensus has gathered around quarter-on-quarter GDP growth of 0.2 or 0.3 per cent, just below the 0.4 per cent implied in the Reserve Bank of Australia's own policy settings.

The weakness is owed partly to the relative strength of the first quarter, when output expanded by 1.1 per cent, thanks largely to an unusually benign cyclone season and the consequent lift in export volumes.

Net exports, by contrast, are expected to be negative in the second quarter, while slightly disappointing business investment data has also forced a last-minute downgrade of GDP estimates by most banks.

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Some forecasters, among them Macquarie Securities analyst James McIntyre, have not discounted a flat or even negative figure, with much depending on non-farm inventory data and other business contributions - including gross operating profits - due on Monday.

The last time output shrank in a quarter was in early 2011, and that was related to the devastating floods across Queensland.

There are also figures out this week on nominal wages growth and sales, which will provide more clues on the income and production measures of GDP, the total figure on which will be released on Wednesday.

Despite gradually improving business confidence and conditions - shown in most private sector surveys - consumers have been reluctant to spend.

Retail sales fell by 0.2 per cent in the second quarter when adjusted for inflation, according to data from the Australian Bureau of Statistics.

Economists and retailers have partly blamed an unpopular May budget. Weather also played a part: a warm start to autumn meant a slow April and May for fashion retailers.

A surprise jump in unemployment, to 6.4 per cent, in July could remain a brake on consumer sentiment in the months ahead.

Despite these weak points, the RBA is highly unlikely to change the 2.5 per cent cash rate at its monthly policy meeting on Tuesday.

Instead, RBA-watchers will focus on any signs of concern about GDP growth or about the persistent strength of the dollar, which is itself stymieing Australia's smooth transition to non-mining investment led growth.

"We expect the RBA to keep the cash rate steady again and we'll be looking for any comment on [last] week's construction and investment data and how that might be influencing the RBA's outlook for the economy's transition to more domestically-oriented growth," National Australia Bank said.

RBA governor Glenn Stevens is also speaking in Adelaide on Wednesday.

Along with the GDP figures on Wednesday, National Australia Bank releases its online retail index for July. This will be followed by the ABS' retail trade report for July on Thursday. Building approvals for July are out on Tuesday.

Despite softening commodity prices, declining real income and low inflation, the Australian dollar has barely budged from within a tight trading range between US92 and US95 since March.

Although assisting companies that rely on capital imports to do business, the high dollar makes non-mining exporters and export-exposed companies less competitive.

The strength of the local unit, ascribed mainly to the attractiveness of the returns on Australian financial assets, property and infrastructure, has been a source of frustration for the RBA and lawmakers.

"As expected, mining investment is falling sharply and, although resources exports are ramping up, the mining sector is contributing less to growth than it was in previous years," HSBC chief economist Paul Bloxham said in a note.

"Low interest rates are also largely doing their job, supporting housing prices and dwelling construction. But, in the face of falling commodity prices, the high Australian dollar has acted as a drag on income growth.

"It has also hindered competitiveness and appears to be discouraging non-mining business investment," he said.

Despite warnings from Governor Stevens that the Aussie will eventually correct in line with trade and relative price fundamentals, most commentators are moving to the view that the currency won't change much until well after the US Federal Reserve starts lifting its interest rates.

"The Fed's already told you they are going to tighten," says Deutsche Bank chief economist for Australia Adam Boyton.

"Markets are forward looking - so for the Fed to have an impact on the Australian dollar, it theoretically has to tighten by more than what [the market] is already expecting for there to be much impact on the dollar."

The differential between the Australian and US 10-year bond rate has also dropped to below 100 basis points, but the Aussie has not moved in line with the differential.

Meanwhile, talk of further easing in the European Community, which is struggling against deflationary pressures and flat growth, has added to the Australian dollar's allure to portfolio investors.

The local currency has risen more than 2 per cent against the common currency in August, to as high as 70.98 euro cents, making this Thursday's European Central Bank board meeting of special interest to dollar watchers.